Friday, May 18, 2012

The 2011 10-Year Stock Market Projection

Note: The purpose of this post is just to archive the original 2011 projection for posterity. For the current yearly projection, see The 10-Year Stock Market Projection. The original post for 2011 follows....

This post presents projected stock market returns for the "next" 10 years -- beginning in January 2011. It also shows the actual results for the most recently completed 10-year period.

Projected 10-Year Stock Market Returns

The above graph (click to expand) shows my projected returns for the DJIA (Dow Jones Industrial Average) for 10-year periods beginning end-of-year 2000 through 2010. The dotted red line estimates the return that a hypothetical investor in the stock market would receive over the next ten years if he

invested at the end of the starting year and sold 10 years later -- reinvesting dividends during the intervening ten years. The estimates are as they would have been calculated at the beginning of each 10-year period.

An earlier post "backtested" the original methodology and showed projected vs. actual results from 1900 through 1999 (the last year for which actual results were available at the time). Basically, it was what I would call "proof of concept" -- we were testing the concept out. This is the first year we can see the projections compared to actuals that could not have been known at the time.

2000 10-Year Stock Market Projection vs. Actual 2000-2010 Results

Actual returns continue to exceed projected returns, as was true in the final years of the backtest. While actual returns were very modest (3.1%/year), they were still better than the 0.1%/year projected by the model. How accurate a forecast you think that is depends on your point of view. However, remember I'm not forecasting the future, I'm projecting the future. I think the proper way to think about it is that in 2000 the model (would have) projected very modest returns -- in the lower range of historical returns -- and that's what happened.

Actually, I have made a small improvement in the methodology since the original backtest. The net result is that the highest and lowest projections are less extreme, and the projections are slightly more accurate than the original projections. For example, the original 2000-2010 projection was for losses of 0.9%/year. (Note: The decision to modify the methodology was made before I knew that it would improve the 2000-2010 projection.)

Projecting Returns for the Next 10 Years (Beginning Year-End 2010)

As you can see from the chart, since 2000 the model has consistently projected very modest, though still positive, returns. In fact, the 2000 projection is the second lowest ever; the 1999 forecast was for a loss of 1.1%/year. The 2008 crash lowered prices enough to increase prospective returns somewhat. However, even the 7.4% annual returns projected at year-end 2008 are still below average returns. Since then, above average market increases have in effect borrowed returns from the future such that by year-end 2010 the projected returns had been reduced to 5.4%. In addition, I estimate that by the end of the first quarter, this number had been reduced further -- to around 4.7%.

Conclusion

As I have said before, I prefer to describe this as a stock market projection rather than a stock market forecast. The reality is, no one knows for sure where the stock market will be 10 years from now -- it's the future! I think of the above graph as establishing a benchmark. It says IF normalized earnings grow at the historical rate*, and IF 10 years from now the market is applying average* valuations in terms of earnings multiples, THEN these are the results an average buy-and-hold investor can expect. The chances of this scenario playing out exactly are, I think, remote. However, a look at previous results suggests the chances of actual returns being in the projected "ballpark" are quite high. In short, with all its imperfections, I think it's a good place to start our thinking about future returns.

Note: For the most recent projection, see the current Monthly Stock Market Update.

* Results based upon my Stock Market Analysis Model/Spreadsheet. Average earnings growth rates and p/e ratios are based on "full-cycle" results from 1941-1982.